esb group response: integrated single electricity market (i-sem) …€¦ · common practice in...

i Esb I-Sem Market Power Consultation Response Final

ESB Group Response:

Integrated Single Electricity Market

(I-SEM)

Market Power Mitigation Consultation paper

SEM-15-094

18th January 2016

ii Esb I-Sem Market Power Consultation Response Final

Contents

Executive summary ............................................................................................................................ 1

1. Introduction .................................................................................................................................. 5

2. Proportionality .............................................................................................................................. 5

2.1 Better Regulation Principles .................................................................................................. 6

2.2 The importance of a holistic view of I-SEM ........................................................................... 6

3. Context for Market Power Assessment ........................................................................................ 8

3.1 Assessing market power in I-SEM ........................................................................................ 8

3.2 Market power assessment framework ................................................................................ 10

3.3 Market definition ................................................................................................................. 10

3.4 Market power metrics ......................................................................................................... 12

3.5 Structural market power modelling ...................................................................................... 14

4. Market Power Focus Areas ........................................................................................................ 16

4.1 Market Monitoring ............................................................................................................... 16

4.2 Forward Contracting Obligation .......................................................................................... 16

4.3 Day ahead and intraday market bid mitigation .................................................................... 18

4.4 Balancing market bid mitigation .......................................................................................... 19

4.5 Removal of ESB’s vertical ring-fence .................................................................................. 20

4.5.1 The Benefits (i.e. Cost Savings) from Vertical Integration ............................................ 21

4.5.2 Vertical Integration, Forward Liquidity and Foreclosure ............................................... 22

4.5.2.1 Forward Liquidity ...................................................................................................... 22

4.5.2.2 Foreclosure .............................................................................................................. 23

4.5.3 Vertical integration and informational advantages ........................................................ 25

4.5.4 Vertical integration as a more efficient structural remedy ............................................. 26

4.5.5 Summary of Vertical Integration Arguments ................................................................. 27

Appendix 1: Responses to consultation questions ............................................................................ 28

Appendix 2: I-SEM market definitions and design features that mitigate market power ..................... 35

1 ESB I-SEM Market Power Consultation Response Final

EXECUTIVE SUMMARY

The implementation of I-SEM represents a significant change for the All Island electricity market, and will

lead to much tighter integration with other European markets. The new design will change the dynamic of

how the market operates, introduce new risks and opportunities for market participants, and lead to much

greater cross-border activity. At the same time, the market is becoming increasingly competitive, limiting

the ability of any one player to be able to exploit market power.

Decisions on market power mitigation measures should be considered in the context of the

changing market and competitive dynamics, and not simply based on a roll forward of existing

SEM measures.

There should not be a presumption that market power exists in the I-SEM, or that participants would

exploit it. The scope of measures being considered in the consultation document is a concern in this

respect.

The requirement to comply with the Internal Energy Market (IEM) is the key driver of the transition to I-

SEM. This represents a fundamental shift away from specific national regulatory frameworks as all I-SEM

market participants will have to comply with rules and regulations that are not only country or market

specific, but also with overarching European laws. It is important that this level of regulation is fully taken

into account when assessing the need for additional measures to address market power concerns. With

initiatives such as European Regulation on Wholesale Energy Market Integrity and Transparency (REMIT),

market power mitigation is becoming increasingly focused on ex-post regulation, supported by robust

market monitoring. Furthermore, the design of I-SEM and indeed the rules of the IEM already contain

numerous in-built mitigations to prevent the exploitation of market power and these should also be taken

into consideration.

We believe that there is a strong link between some of the measures (Forward Contracting Obligation

(FCO) and vertical integration) being considered in this consultation, and measures that may be

implemented to promote liquidity.

It is ESB’s contention that provision of sufficient forward liquidity is the greatest risk to a

successful implementation of I-SEM, given the structural lack of hedgeable generation as more and

more intermittent generation is commissioned1. A continuation of the status quo is not tenable, as

by 2020 the volume of Directed Contracts (DCs) available will naturally decrease to c. 2TWh (with

only c.1TWh going to third parties), and the Public Service Obligation (PSO) backed hedges, which

ESB currently and voluntarily administers on behalf of the CER, will have stopped, meaning the

existing sources of liquidity can no longer be relied upon.

Hence, it is very important that these issues should be considered in the round. There is a risk that

sequential decision-making to address discrete issues will lead to an overall package that is

disproportionate and/or insufficient to allow participants the ability to manage their trading exposures.

The key principles adopted by governments and competition authorities include that intervention must be

reasonable and proportionate, that is, it achieves an identified aim, but:

is no more onerous than is needed to achieve its aim; and

does not produce disadvantages that are disproportionate to the aim.

1 with 40% wind, only a portion of the remaining 60% thermal generation will be able to offer hedges


Proportionality is enshrined both (i) as a principle of good regulation (as part of the Better Regulation

Principles at EU and national level) and (ii) as a legal principle both under EU law, which underpins

electricity regulation, and as a matter of national administrative law.

Therefore in setting its I-SEM market power policy, the SEM Committee must act reasonably and only

adopt measures that when taken in aggregate are proportionate to the level of risk they are intended to

address, and be consistent with the wider IEM.

ESB is concerned that over burdening (or “pancaking”) I-SEM with ex-ante interventions related to

market power and applied only to Irish participants, risks placing those participants at a

competitive disadvantage relative to others in the wider IEM who are not subject to such rules,

thus distorting competition and threatening the free movement of goods and services, contrary to

the objectives of the IEM. This risks a disproportionate response which could damage the

development of competition in the longer run, which would not be in I-SEM customers’ interest.

It is important to note that the European Commission indicates where a company has a market share of

less than 40%, it is unlikely to be dominant2. Additionally, the European Court of Justice (ECJ) has alluded

to a presumption of dominance at 50%3 but not 40%. In fact, there is effectively a presumption that there is

no dominance under 40%.

The SEM has been very successful in attracting competition into the All Island market and a reasonable

assessment of market shares and other competition metrics (as conducted by the Regulatory Authorities

(RAs), ESB and others) shows that very early into the lifetime of the I-SEM, ESB’s market share of 31.2%

in 2020 is not indicative of dominance nor is ESB pivotal in 2016 and 2019 using an Residual Supply Index

(RSI) of 1.1.

Furthermore, we consider the modelled outcomes presented in the consultation paper, are (by the RAs’

own admission) a worst case scenario outlook. This is particularly pertinent to 2024, which from a

structural market power perspective, lacks any credibility as a modelling outcome upon which policies

should be based, for the following reasons:

The assumption that there no ESB plant closures

High demand growth scenario used as a base case

The exclusion of any further interconnection from the base case

DSU assumptions - which if based on the Generation Capacity Statement forecast for 2024 we understand to have been surpassed in 2015

The impact of interconnector flows under Euphemia not accounted for

We also have concerns around the choice for modelling the year 2019, as we consider 2020 to be more

relevant given the extent of changes expected in the generation fleet in 2019. In addition the overly

simplistic assumption regarding demand uplift in balancing timeframes significantly overstates the market

power assessment for the balancing market (BM) across all years modelled.

We would also contest the RAs’ definition of the forward market, which ESB considers is wider than

proposed by the RAs. The consultation document states that “The largest possible geographic market in I-

SEM includes all generators and load on the island, and the capacity of the interconnectors with GB, since

that is the limit on cross-border (or between bidding zone) competition.” Whilst this is true in the context of

‘clean’ hedges, it ignores the possibility of ‘proxy’ hedging using a market which is highly correlated. This is

2 See following link: http://ec.europa.eu/competition/antitrust/procedures_102_en.html

3 Case 62/86, AKZO v Commission, para 60


common practice in many European electricity markets, and is a risk management strategy currently

employed by ESB and other SEM participants. I-SEM participants will have the option of using GB forward

electricity contracts as a proxy hedge (even without transmission rights on interconnectors) or underlying

gas and carbon markets which are also highly correlated.

Even using conservative assumptions, and an overly narrow definition of the forward market,

market share and RSI metrics suggest that ESB is not structurally dominant.

Within the overall framework put forward by the RAs to assess market power, most of the focus has been

on the structural issues and there has been no assessment of either conduct or performance. It is

imperative that such an analysis is undertaken given the greater burden of proof necessary for any ex-ante

market power mitigation measures, as ESB’s market share falls below 40%.

Notwithstanding the illegality of plant withholding/strategic bidding (under the grid code and REMIT), we

have conducted analysis (for the purposes of this consultation) to demonstrate the negative/marginal gain

of such an endeavour. This analysis demonstrates that ESB plant withholding/strategic bidding at the day

ahead (DA) results in only marginal benefits at the portfolio level, and often results in decreases in margins

(certainly within the margin of forecast error). This highlights the fact that the risks from such a strategy

(due to factors such as REMIT and the level of uncertainty due to high wind generation levels) far

outweighs the small benefits that might be gained and demonstrates that such a strategy would not be

followed.

While the framework adopted to assess market power (Structural, Conduct and Performance basis)

is welcomed, there has not been an adequate assessment conducted (ex-ante) along these lines.

This is a fundamental necessity given the level of intervention being considered and the risks that

would be imposed on ESB as a result.

The structural analysis demonstrates that market power should not be a concern in the prompt and

forwards markets. The transparency requirements and ex-post enforcement of market abuse provided for

under the legislative framework, including REMIT and competition law, together with a well-resourced

Market Monitoring Unit (MMU) should be sufficient to address any residual market power concerns.

The Balancing Market (BM) is the one area where we understand that there may be concerns regarding

the potential to exercise market power. This issue is not specific to I-SEM, and in most equivalent markets

internationally there is the potential for participants to exercise locational or temporal market power, and

not necessarily just the larger players. Again, ex-post measures are normally deemed sufficient. However,

we understand there may be a case for explicit short run marginal cost (SRMC) based bidding principles

for balancing actions required to alleviate transmission constraints, or for other types of balancing actions

where competition may be limited. These principles must recognise opportunity costs and risk premia

associated with the risk of outage whilst delivering balancing actions.

We note that under such an approach, some plant which may be required for managing transmission

constraints may fail to clear in the capacity auctions, and be unable to cover the remainder of their fixed

costs by bidding in scarcity into the BM. For these plants, additional bilateral contracts with the TSO may

be required to prevent them exiting the market, or greater degrees of bidding freedom permitted.

We do not believe there is a strong case requiring SRMC bidding restrictions for energy related actions,

since this has the potential to distort the market by weakening balancing incentives, and interfering with

cross-border flows. However, ESB considers, that where ambiguity or the potential for ambiguity exists

that clarity is important and so a clearly defined set of guidelines (with flexibility enshrined in them) would

aid all market participants.

With effective regulation in the BM there should be no further requirement for ex-ante measures in the DA

or intraday (ID) markets. Likewise we see no case for an FCO.


A feature of any well-functioning market is a forward market where participants are able to access at any

time the hedges they need at a forward price that can be relied upon. This is to the benefit of all players,

including larger vertically integrated players for the purposes of hedging their assets and setting retail

tariffs, and for smaller non-integrated players who need access to risk management products to manage

their businesses. Given the structural issues with liquidity in the market, ESB would be willing to support a

holistic approach for promoting liquidity in conjunction with other larger players. We believe that this would

be a far more effective means for promoting a competitive market than an FCO, which would reduce the

ability of ESB to provide more continuous liquidity to the market.

We believe that regulating the BM and ensuring there is sufficient continuous liquidity in the

forward market and a reliable forward price should be the main concerns for the SEM Committee,

and any ex-ante interventions should be targeted in these areas.

In light of this, we see no rationale for the continuation of ESB’s vertical ring-fence since it is unrelated to

market power in the BM and provides little benefit in terms of liquidity and providing a reliable forward

curve.

Vertical integration is a common organisational structure in electricity markets and under I-SEM ESB will

be competing against a number of vertically integrated within the IEM. A number of these firms, Centrica

and SSE, already operate within the SEM.

The SEM Committee has raised concerns that vertical integration risks foreclosure. The findings of the

Competition and Markets Authority (CMA) in GB are relevant to address this question. The CMA found that

input foreclosure by a vertically integrated player would be a costly strategy with limited potential gain and

potentially negative impacts for the vertically integrated firm’s own supply business. We believe these

findings have strong parallels in I-SEM and should be considered.

There are also a number of benefits of vertical integration. We estimate that ESB, with the removal of ring-

fencing, could eliminate existing inefficiencies from its business of c. €12m annually. Further, we estimate

that the removal of the ring-fence in advance of I-SEM would avoid ESB having to incur significant

additional capital expenditure of c. €17m and the imposition of additional ongoing inefficiencies of c. €14m

per annum in order to operate in I-SEM. This would be achieved through the removal of duplication and

the ability to make more efficient risk management decisions. Avoiding these costs will afford ESB greater

flexibility in pricing appropriately to market conditions with knock on benefit for customers.. Furthermore,

ESB would be better able to offer risk management products to the market, including forward hedges and

potentially other tailored products. This will be important given that participants will be faced with greater

risk exposures under I-SEM when compared to the current SEM. A decision on this is urgently required in

order to allow Electric Ireland sufficient time to implement the required processes and systems, for I-SEM

commencement (while remaining compliant with public procurement rules).

The continuation of the vertical ring-fence is manifestly disproportionate and is not necessary.

This ex-ante regulatory intervention simply cannot be justified any longer when one has regard to

the changing regulatory landscape, ESB’s declining market shares and the increase in competition

from large, vertically integrated undertakings. A vertically integrated ESB would realise efficiencies

that can benefit all I-SEM customers, and would make it better able to provide risk management

products to the wider market helping to promote competition.


1. INTRODUCTION

ESB is pleased to respond to the Regulatory Authorities’ (“RA”s’) consultation paper on I-SEM Market

Power Mitigation (SEM-15-094). This response is from ESB Group and has the following structure:

In sections 2-4 we outline key issues and considerations that relate to the assessment of market power in I-SEM;

In Appendix 1 we respond to each of the questions posed in the consultation paper; and

The Appendices set out additional information that supports our position.

2. PROPORTIONALITY

One of the key principles adopted by Governments and competition authorities is that any intervention to

mitigate the potential to exploit market power must be reasonable and proportionate. That is, it achieves its

aim, but that:

it is no more onerous than is needed to achieve its aim; and

it does not produce disadvantages that are disproportionate to the aim.

Proportionality is enshrined both (i) as a principle of good regulation (as part of the Better Regulation

Principles at EU and national level) and (ii) as a legal principle both under EU law4, which underpins

electricity regulation, and as a matter of national administrative law. For the reasons set out below, we are

concerned about the potential for over burdening I-SEM with ex-ante market power interventions, which

apply only to Irish participants and risks placing them at a competitive disadvantage relative to others in

the wider IEM who are not subject to such rules. This approach risks distorting competition between

Member States and threatening the free movement of goods and services, contrary to the objectives of the

IEM. We do not believe this is in the interest of I-SEM customers.

In this regard, we wish to highlight the following general objectives of national regulatory authorities as specified in Article 36 of the Electricity Directive 2009/72/EC:

“(a) promoting, in close cooperation with the Agency, regulatory authorities of other Member States

and the Commission, a competitive, secure and environmentally sustainable internal market in

electricity within the Community, and effective market opening for all customers and suppliers in the

Community and ensuring appropriate conditions for the effective and reliable operation of electricity

networks, taking into account long-term objectives;

(b) developing competitive and properly functioning regional markets within the Community in

view of the achievement of the objectives referred to in point (a);

(c) eliminating restrictions on trade in electricity between Member States, including developing

appropriate cross-border transmission capacities to meet demand and enhancing the integration of

national markets which may facilitate electricity flows across the Community;” (our emphasis added)

We believe there is a strong link between the different I-SEM markets and the measures being considered

to mitigate the potential exercise of market power. If sequential decisions are made on discrete issues,

rather than by adopting a more holistic approach, there is a significant risk that the overall package will

lack cohesion, be unworkable and disproportionate. It is therefore of paramount importance that any

decision to intervene is thoroughly scrutinised and based on robust evidence to ensure the right

competitive balance that delivers optimal outcomes for customers. Such an approach should be consistent

4 See for example Case C 101-12 Herbert Schaible v Land Baden-Wuerttemburg at para 32: “According to well-established case-law, the

principle of proportionality is a general principle of EU law and requires that measures implemented through its provisions ‘be appropriate for attaining the legitimate objectives pursued by the legislation at issue and [do] not go beyond what is necessary to achieve them’.”


with principles of EU law and the Irish Better Regulation principles, which as noted above, include

proportionality. The RAs’ commitment to evidence-based decision making is key throughout this process in

order to demonstrate that the aim of any proposed intervention is legitimate and that the measure is

proportionate to achieving that aim. We see the move to I-SEM as a significant market change, and any

measures need to be considered in light of this new market design and wider European regulatory

framework, and not just as a simple roll-over of the existing arrangements from SEM.

We therefore urge the RAs to act reasonably and only adopt measures that when taken in aggregate are

proportionate and tailored to the level and nature of risk which the RAs are seeking to address, and are

consistent with the wider IEM.

2.1 Better Regulation Principles

The approach taken to mitigate concerns about the exercise of market power should be proportionate to

any structural concerns as well as the incentives identified and that they could be ex-post in nature. This is

one of our key concerns.

For example, we note the following statement from section 4.2.6:

“In general, the RAs consider that generators should not be allowed to include their own expectation of

scarcity rents or future inframarginal rents in their offers because there is a concern of not being able to

differentiate between the exercise of market power and genuine legitimate behaviour leading to high

prices due to scarcity.”

This issue of interpreting the ‘legitimacy’ of behaviour with respect to pricing above SRMC is inherent in

competitive electricity markets everywhere (and particularly in energy-only market designs). The issue for

regulators then is how to deal with the inherent uncertainty – balancing the need to mitigate the potential to

exploit market power with the need to ensure efficient dispatch and investment signals.

The consultation document goes on to state that:

“…these issues [of uncertainty] are best addressed by appropriate market design…”

This statement appears to pre-suppose that an ex-ante (rather than ex-post) intervention is desirable to

manage the uncertainty. Ex-ante and ex-post interventions each involve different challenges. The key

distinction is that ex-ante interventions can stifle innovation, face a higher risk of regulatory failure due to

the significant informational and analytical requirements, and impose a considerable regulatory burden on

participants. Ex-post interventions are not necessarily limited in this way.

We would therefore question whether it is appropriate to maintain a principle that ex-ante intervention is

preferred in all circumstances. Rather, the application of any intervention should be tested against the Irish

Better Regulation Principles. We provide an initial high-level assessment against each of the principles in

Appendix 1. For the reasons set out in that appendix, we believe caution should be applied before deciding

to intervene ex-ante. It is therefore of paramount importance that any decision to intervene ex-ante is

thoroughly scrutinised, based on robust evidence and satisfies the Irish Better Regulation Principles.

2.2 The importance of a holistic view of I-SEM

There is a strong link between the different I-SEM markets and the measures being considered to mitigate

the potential exercise of market power. Below we provide high-level responses to each of the key

interactions noted in the consultation document. This is a challenging space as these interactions are

complex, the design of I-SEM is still a work in progress in places as are certain elements of the IEM. It

would also be helpful to have visibility of the measures being considered for the Capacity Remuneration


Mechanism (CRM) and DS3 markets and being able to compare these measures alongside the other I-

SEM markets.

With this in mind, we would point out that as decisions relating to the design of each market are taken with

a holistic view of I-SEM the same approach should be applied to any measures to mitigate the potential

exercise of market power. We see a risk that if sequential decisions are made to address discrete issues

the overall package of measures may lack cohesion, be unworkable and disproportionate. This outcome

would not be in the interest of I-SEM customers or participants.

Physical markets

We agree that market coupling will likely have a very significant impact on the ability of any party to

exercise market power in DA market (and later the ID market and potentially BM). This will be true from

day one of I-SEM, through increased efficiency of flows across the existing EWIC and Moyle

interconnectors. Furthermore, a number of credible new interconnector projects could be commissioned in

the coming years (for example to GB and or France). As confirmed by the RAs’ own analysis in chapter 6

of the consultation document, this increased competition will have a significant impact on the ability of any

party in I-SEM to exercise market power in DA and ID markets. This impact should not be downplayed.

We can understand that the exercise of local or temporal market power in the BM is a key concern for the

RAs. However the potential exercise of local market power would apply only in specific circumstances, and

this is not an issue unique to I-SEM, and therefore we would argue that any intervention should be

specifically targeted to this case so as not to undermine competition in the energy market itself.

CRM

As the RAs acknowledge in the consultation document, the CRM design choice of a Reliability Option (RO)

is itself a market power mitigation measure, as it reduces the incentive to bid in DA, ID market and BM

markets above the RO strike price. We would argue that this behavioural incentive should be given greater

weight in the ‘Structure-Conduct-Performance’ (SCP) framework put forward (i.e. as an indicator of likely

conduct under I-SEM). It is in precisely these extreme ‘scarcity’ periods when the majority of plant are

running that market power concerns may be greatest. Indeed, our analysis indicates that the degree of

competition is quite strong at ‘medium’ levels of demand. Prices in the €200-300/MWh range are regularly

seen in the SEM. The CRM would act to limit prices (via the Market Reference Price (MRP)) rising above

this ‘marginal peaking plant SRMC’ level in periods of scarcity, and competition should ensure competitive

pricing below this level.

Further, while we agree that the interaction between the CRM and the physical markets (via the MRP)

could drive different incentives depending on relative RO holdings, this would tend to increase ‘missing

money’ and thus the RO option fees, the certainty of which may be preferred by market participants.

Provided that the CRM auction is transparent and competitive the combined effect should be for a

reduction in the incentive for the exercise of market power in the energy market.

FTRs

While the consultation document rightly points out the interaction between FTRs and the physical markets,

we would argue that the likelihood of a single party being able to manipulate prices across two markets

(spreads overall) and thus increase (or decrease) the value of FTRs is remote.

DS3

Transparent and competitive procurement mechanisms should limit the ability of any party to exercise

market power in setting availability payments under DS3. This should be dealt with as part of the

auction/tender design for DS3.


While the consultation document rightly points out the interaction across energy and ancillary services

close to real time, we would argue that the ability to exercise local market power in the BM should be

greatly reduced for a DS3 provider under SO dispatch instructions.

3. CONTEXT FOR MARKET POWER ASSESSMENT

Market power is a feature of all electricity markets, and unlike in some other markets, the need to balance

supply and demand instantaneously and simultaneously across the network, means that small as well as

larger players can have temporal or locational market power. Hence, market power and measures to

mitigate it are a key consideration in all electricity markets including I-SEM. In this section we set out the

key context for assessing market power in I-SEM and put forward our view of the appropriate market

definitions, metrics and modelling to carry out that assessment.

3.1 Assessing market power in I-SEM

The implementation of I-SEM represents a significant change for the All Island electricity market that will

lead to further integration with other European markets. At the heart of the I-SEM philosophy is a

preference for competitive approaches that are in the interest of customers and equal access to all I-SEM

markets for participants of all sizes and technologies. The chosen high level and detailed design enshrines

this. The RAs’ commitment to evidence-based decision-making further underpins this. We consider this is

important basis within the context of assessing market power.

It is essential that any market power mitigation in I-SEM is thoroughly evaluated in the wider context of the

transition to, and integration with the IEM. The IEM is a central pillar of European energy policy. The vision

is for a fully integrated European electricity market with active cross-border trading, and competition where

participation in the market is not defined by national borders, but rather by natural trading hubs and

satellite markets. The IEM comprises a legally binding set of common technical and commercial rules and

obligations that govern access to and use of the European energy networks. There are a number of

phases to trading in the IEM, starting with the trading of long term cross-border transmission rights, this is

followed by DA market coupling, and then continuous intraday trading and ultimately common balancing

arrangements. These common market rules are further supported by common technical rules for

connections within the IEM and for operating the transmission networks that make up the IEM. This

represents a fundamental shift away from specific national regulatory frameworks. I-SEM is a significantly

different market design to the SEM and there should not be a presumption of carry-over of the market

power mitigation measures.

All I-SEM market participants must comply with a host of rules and regulations comprising European

regulation (including national implementation of EU laws) as well as domestic and market-specific

requirements. It is important these are taken in account when assessing the need for any further measures

to address any market power concerns. The design of I-SEM and the IEM also contains numerous in built

mitigations to prevent the exploitation of market power (such as unit based bidding, the exclusive nature of

the DA market/ID market), which are set out in detail in Appendix 2.

There is a significant body of legislation in place which already provides considerable protection against

market abuse and provides for increased levels of transparency. In particular, it is worth drawing attention

to EU and national competition law and the REMIT in addition to various EU measures targeted at market

abuse in financial transactions (including the Market Abuse Directive and the Market Abuse Regulation).

Applicable competition law is set out in the EU Treaty and, at a national level (in Ireland) in the

Competition Act 2002 to 2014 (the “Competition Act”). Article 101 of the EU Treaty (Section 4 of the

Competition Act) prohibits anti-competitive agreements while article 102 (section 5 of the Competition Act)

prohibits the abuse of a dominant position. Competition law is enforced both by the European

Commission and national authorities (e.g. the Competition Authority in Ireland, the Competition


Commission in GB - and we are aware that the Utility regulator has competition enforcement powers in

Northern Ireland).

REMIT is an European regulation, binding in all Member States, which introduces a sector-specific legal

framework for the monitoring of wholesale energy markets. The objective of REMIT is to ensure that

customers and other market participants can have confidence that prices set are fair and competitive and

that no profit can be drawn from market abuse. Under the structure put in place for REMIT, energy trading

will be monitored at domestic and EU level to uncover abuses.

REMIT consists of three pillars as follows:

1. Prohibition of market manipulation and trading on inside information

2. A transaction and data reporting framework to allow for EU wide market monitoring by the Agency

for the Cooperation of Energy Regulators (ACER) and national regulatory authorities

3. Provision to ensure any potential incidents are investigated and action is taken

REMIT also established mechanisms for the sharing of information about wholesale energy market

transactions amongst relevant authorities, in particular with other national regulatory authorities including,

financial (e.g., wholesale energy products which are financial instruments – EMIR) and competition

authorities.

The introduction of REMIT is relatively new in the context of the SEM market power mitigations that are

currently in place and we feel this changes the basis against which the design of market power mitigation

measures for I-SEM are assessed.

Competition law and REMIT provide EU and national regulators with the power to investigate and enforce

any breach of market abuse rules ex-post. In addition, the increased transparency requirements under

REMIT assist regulators in uncovering market abuse and by triggering the investigation of suspicious

behaviour. This is further supported by the requirements of Regulation 543/2013/EU (the “Transparency

Regulation”). Through this Regulation, the submission by TSOs of fundamental information related to

electricity generation, load, transmission and balancing for publication through the European Network of

Transmission System Operators for Electricity’s (ENTSO-E) Transparency Platform has become

mandatory.

Whilst we note that in the consultation paper the RAs have acknowledged the introduction of REMIT and

the increased scope for effective ex-post regulation, we have not seen evidence that this has been duly

taken account of in the approach being proposed to market power mitigation in I-SEM.

This increased level of market transparency provides a platform for effective ex-post regulation. The

application of REMIT and the impact that it is having on market participants should not be underestimated,

given the extent of penalties that can be applied.5 The regulatory framework is a complex, multi-faceted

environment and a thorough evaluation is essential to ensure a cohesive and proportionate set of

measures is put in place.

I-SEM will, by virtue of its design, impose greater risk on participants that they do not currently face in the

SEM. These range from marginal cash-out prices for being out of balance, the potential for financial

penalties and competitive procurement processes. Market participants will need to adopt new strategies

and approaches to manage risk and comply with these new market rules.

5 Of note is the recent announcement by Spain’s CNMC fining Iberdrola €25m for a breach of REMIT. Notably, this decision dates back to

before the requirement for data collection under REMIT had commenced. http://www.cnmc.es/CNMC/Prensa/TabId/254/ArtMID/6629/ArticleID/1547/La-CNMC-sanciona-a-Iberdrola-Generaci243n-con-25-millones-de-euros-por-manipulaci243n-en-el-precio-de-la-energ237a-el233ctrica.aspx


3.2 Market power assessment framework

We support the application of the SCP framework to assess market power in I-SEM. We do, however,

have concerns that the RAs’ analysis has not given sufficient consideration to the conduct and

performance dimensions. It is imperative that further analysis on these aspects of the framework is

undertaken to compile a robust evidence base on which informed evidenced based decisions can be

made.

Notwithstanding the illegality of plant withholding/strategic bidding (under the grid code and REMIT), we

have conducted analysis (for the purposes of this consultation) to demonstrate the negative/marginal gain

of such an endeavour. This analysis considers plant withholding / strategic bidding strategies at the DA

stage and results in either negative or only marginal gains. The risks from such an approach (due to

factors such as REMIT and the level of uncertainty due to high wind generation levels) far outweighs the

small benefits that could be gained and demonstrates that such a strategy would not be viable. We outline

our analysis in more detail in a separate confidential submission accompanying this consultation response.

We would contend, however, that the assessment undertaken has a number of shortcomings that

overstate the potential extent of market power in I-SEM. It is ESB’s view that market power is not a

concern at all in the I-SEM forward, DA and ID markets and any market power concerns that remain are in

the BM only, noting that we are yet to see the RAs assessment of the CRM or DS3 markets. We explain

the reasons for this position in the following sections.

3.3 Market definition

Defining the applicable market(s) is a necessary prerequisite to assessing market power. We agree that

product, geography and time are the correct dimensions to define the I-SEM markets.

In our view, the relevant markets for assessing market power become wider with integration to the IEM,

whilst greater convergence across markets will also provide I-SEM participants with more options for

managing risk. The RAs have acknowledged that the corresponding evaluation of market power under I-

SEM needs to be from a broader geographic perspective6. However this sentiment has not progressed into

the consultation. In Table 1 we suggests potential market definitions (product and geography) that could

apply to I-SEM.

Table 1 Potential I-SEM product and geographic market definitions7

I-SEM market Product Geography

Forward Any physical or financial market where a participant can

manage its forward market exposures

Regional (I-SEM + GB)

Day Ahead A physical contract to generate or supply electricity, traded

through day ahead auctions

Pan-European (subject

to physical IC capacity)

Intraday A physical contract to generate or supply electricity, traded

through continuous intraday platforms

Pan-European (subject

to physical IC capacity)

Balancing Incremental offers to increase production/decrease

consumption or decremental bids to decrease

production/increase consumption

Island of Ireland

6 SEM Committee, I-SEM Market Power Mitigation discussion paper, SEM-15-031, p 8.

7 We envisage four possible geographic market definitions under I-SEM. Local i.e. distinction areas within the Island of Ireland. Bidding

Zone i.e. the Island of Island. Regional i.e. I-SEM and GB (the market(s) I-SEM is directly connected to). Pan-European referring to the Internal Energy Market.


We primarily disagree with the consultation paper suggestions regarding the geographic market definition

for the forwards timeframe. The paper states that:

“The largest possible geographic market in I-SEM includes all generators and load on the island, and

the capacity of the interconnectors with GB, since that is the limit on cross-border (or between bidding

zone) competition.”

Whilst this is true in the context of ‘clean’ hedges, it completely ignores the possibility of ‘proxy’ hedging

using a market which is highly correlated. This is common practice in many European electricity markets,

and is a risk management strategy currently employed by ESB and other SEM participants. I-SEM

participants have the option of using GB forward electricity contracts as a proxy hedge (even without

transmission rights on interconnectors) or underlying gas and carbon markets which are also highly

correlated.

In this regard, we note that the European Commission has considered the appropriate geographic market

for financial products in several merger cases and whilst it has not been necessary to reach a definitive

conclusion, it has indicated a recognition that this can be wider than national and possibly even EEA-

wide8.

While this definition of the forwards market has limited impact on the market power policies being

proposed (given that the paper considers market power in the forwards market to be less of a concern and

successfully mitigated by EU financial regulations), it could have an impact on I-SEM liquidity in the future

as any FCO provided for under market power mitigation proposals will reduce over time (as ESB market

share reduces). In this regard any liquidity obligation (that ties in with a holistic liquidity mechanism) should

be more market based than the current regime under SEM.

In addition the DA and ID markets involve common rules and processes (applicable under Euphemia and

XBID) and are therefore best thought of as pan-European. While at times these may be restricted due to

physical interconnector capacity, with market coupling, increased convergence of the two markets can be

expected in line with outcomes in the wider IEM.

Finally, we recognise the I-SEM boundary for the BM and that whatever residual market power concerns

remain, they are most heightened in the BM. Our primary concern is the RAs’ assessment of the

geographic scope applied to the I-SEM forward market. We believe that the forward market should be

thought of, at a minimum, as having a regional geographic scope. We commissioned a report from Baringa

Partners to explore the appropriate scope of the I-SEM forward market. Box 1 sets out the key findings of

that report. The full report is attached to this response.

Whilst we do not expect that other participants will explicitly subscribe to this view, we note that, all other

SEM participants (including those much larger than ESB when assessed from a regional or pan-European

perspective) benefit from the inefficiencies imposed on ESB as a result of regulatory interventions and as

such a maintenance of the status quo is in their interests. However we do not believe this to be in the long

term interests of customers or in the development of competition in I-SEM.

8 See for example Case RWE/Essent M.5467, para 53, Iberdrola/Scottish Power M.4517 para 18-20, RWE/ENSYS M.5711 para 31,

M.5496 Vattenfall/Nuon Energy at para. 9


3.4 Market power metrics

The choice of metrics put forward in the consultation paper is appropriate for assessing the structural

element of the SCP framework. The RAs’ assessment has focused heavily on the structural element of the

SCP framework, so in this respect the three ex-ante measures considered (market share, Herfindahl-

Hirschman Index (HHI) and Residual Supply Index (RSI)) are most relevant.

Market shares or concentration ratios are a simple tool to show the concentration of a market at a given

point in time although it does not capture potential new entrants that may provide competitive pressure.

For example, greater demand side participation and customer responsiveness may increase the elasticity

of demand for electricity and thus weaken any market power. In wholesale electricity markets generation

capacity is often chosen to illustrate the market concentration. This metric shows that ESB’s market share

Box 1: Key findings of Baringa Partners “Forward Hedging under I-SEM” paper

Energy markets are inherently volatile and participants need access to a range of risk management

tools in order to manage their earnings risk. There are essentially three forms of risk hedging: clean

hedging, asset backed hedging and proxy hedging. As well as standard forward contracts, traded

over-the-counter or on-line exchanges, which help participants to lock in earnings from the

wholesale market, there are a range of bespoke contracts that can provide participants with secure

revenue streams outside of the wholesale market. In the Integrated Single Electricity Market (I-

SEM) context these include Reliability Options and DS3 ancillary services contracts.

Market participants, ranging from large integrated utilities to small independent players, will adopt a

range of different strategies for managing their exposures. With the introduction of I-SEM, the Irish

market becomes part of the wider European Internal Energy Market (IEM), and we expect that

participants will increasingly look to the more liquid trading hubs to manage their forward exposures.

This is a pattern we have observed elsewhere following the introduction of market coupling.

With the greater price convergence associated with market coupling, I-SEM participants are able to

hedge their positions in interconnected markets, either ‘cleanly’ where they are holders of

transmission rights on interconnectors, or relying on the high degree of market correlation for proxy

hedging. The correlation of monthly average prices between the current Single Electricity Market

(SEM) System Marginal Price (SMP) and the GB electricity market (which is almost 100 times

deeper in terms of trading volumes than the SEM) is already very strong at 91%, and this is despite

flows frequently in the “wrong” direction to price differentials, an effect that will be eliminated with

market coupling. Likewise, the highly liquid and strongly correlated GB gas market (monthly

average price correlation of 92% to the SMP, with carbon included, and 2000 times deeper than the

SEM) allows for proxy hedging, as well as asset-backed hedged for companies with gas-fired

generation. These strong correlations are due to gas-fired generation being the most common

marginal price setting plant type in both markets.

In this wider definition of the forward market, ESB is not a dominant player, and in fact by European

standards it is a small company. The continuation of the vertical ring-fence would seem unusual,

and a disproportionate intervention, in this context with several much larger vertically integrated

players, including those active in the I-SEM who are not subject to the same restrictions.


in generation continues to decline and will fall below 40%, which is below the level where the European

Commission considers a firm is likely to be dominant9.

The HHI measures the concentration of the relevant market at a given point in time by calculating the sum

of the squared market shares of all market participants in a market thus takes firm scale into account. We

would draw attention to a number of shortcomings of the HHI:

1. Like market shares, HHIs do not capture competitive pressures from new entrants.

2. The HHI is vulnerable to changes in plant ownership. If a generator were to be purchased by an existing Irish participant (e.g. if Centrica or SSE were to conclude a purchase of Viridian Group), upon completion of the transaction, the HHI could potentially increase even though there’s been no actual change to the system itself. This could potentially increase the focus of regulatory market power intervention on ESB, whose portfolio hasn’t changed. This would not be proportionate as the actions of one party could inadvertently impact another.

3. As mentioned above and in the consultation paper, the nature of wholesale electricity markets can mean that a single generator or group of firms have locational or temporal market power during certain periods and could therefore be pivotal, particularly at times of high demand. Wholesale electricity markets are susceptible to the exercise of market power during such periods. The use of market shares or HHI is commonly applied in competition economics but it does not reflect the unique characteristics of wholesale electricity markets.

4. David Newbery in commenting on the traditional measure of market power as HHI states that it “gives implausible results given the low elasticity of demand in electricity spot markets unless it takes accounts of contracting.”

10 Citing the Lerner Index (as a method to describe the price-cost

margin for a firm in direct proportion to its market share and inversely proportional to the elasticity of demand) a firm with high market share operating in a market with low elasticities should result in “very high price-cost mark ups – considerably higher than are observed” and leading to an “apparent inconsistency between theory and evidence.”

ESB would therefore urge caution in overly relying on HHI as a basis for market power assessment and/or

mitigations. A HHI below 1000 suggests an un-concentrated market; and HHI between 1000 and 1800

indicates a moderately concentrated market while an HHI above 1800 indicates a high concentrated

market. Notwithstanding all of the above, the metric shows that market concentration will decline to a level

of moderate concentration over time.

The RSI measures a firm’s potential to exercise market power in the spot market by examining if demand

could be met across a year without the capacity of the specific generator under investigation. We consider

that RSI is a much more suitable measure as it can account for the characteristics of wholesale electricity

markets. We acknowledge there is no absolute consensus on what a critical value of an RSI should be and

while the RAs’ seem to have a preference for 1.2 as the RSI threshold, there is a strong body of evidence

which indicates that 1.1 is more relevant and more accepted.

The California Independent System Operator developed this measure suggesting that an RSI should not be less than 1.2 (120%) at peak or less than 1.1 (110%) for more than 5% of the hours in a year. This is also noted in the RAs’ 2015 Market Power Discussion Paper.

The EC’s sectoral analysis assessment (2007) was based on an RSI threshold test of 1.1.

ACER has recommended screening market power on the basis of whether RSI is below 1.1 in more than 5% of periods

11

Cambridge Economic Policy Associates (CEPA) Market Power and liquidity in SEM used both 1.1 and 1.2 as relevant benchmarks for the assessment of RSI in SEM.

9 http://ec.europa.eu/competition/antitrust/procedures_102_en.html

10 Predicting Market Power in Wholesale Electricity Markets, EUI Working Papers, Newbery, 2009, p. 5.

11 European Gas Target Model: Review and Update, Jan 2015; http://www.acer.europa.eu/Events/Presentation-of-ACER-Gas-Target-

Model-/Documents/European%20Gas%20Target%20Model%20Review%20and%20Update.pdf


David Newbery’s “Predicting Market Power in Wholesale Electricity Markets” EUI Working Papers, RCAS 2009/03 notes that “Most market monitoring units take as a screen an RSI of less than 110%, as this provides for a minimal level of reserves, below which the Loss of Load Probability rises sharply and with it the scarcity value of power”.

It is ESB’s firm contention that an RSI of 1.1 no more than 5% of the time is the most appropriate indicator

to use, and given that ACER (of which the RAs are members) has recommended such a figure for use in

market power screening, we believe that it should be adopted in this assessment also. In this regard the

RSI figures for 2016 and 2019 (the most appropriate of the years modelled in the consultation) are

indicative of no structural market power findings against ESB. When coupled with our own estimation of

ESB market share of 31.2% in 2020 (which we contend that the RAs could easily replicate and verify),

these findings indicate that ESB has no structural market power in I-SEM. The assumptions and outcome

underpinning this analysis are included in a separate confidential submission accompanying this

document.

We agree that the various ex-post measures considered can provide a sound basis for investigation and

enforcement by the MMU, which we believe is vitally important in I-SEM. As discussed above, we would

question the apparent underlying presumption to rely on ex-ante over ex-post measures in mitigating

market power. The impact of ex-post monitoring and enforcement on behavioural incentives should not be

underestimated.

3.5 Structural market power modelling

The SEM has been successful in attracting new entrants and competition has increased since its

commencement in 2007. Reflecting this and on the back of analysis by CEPA the RAs’ 2012 decision

permitted ESB operational horizontal integration. We would also note that since this decision the volume of

non-directed contracts (i.e. liquidity) offered to the market by ESB has actually increased. This is a positive

reflection of the evolution of competition in the market to date. The RAs’ modelling shows this

improvement in competitive pressures is set to continue under I-SEM indicating that potential for the

exploitation of market power is declining.

We have a number of concerns regarding the modelling outputs used to estimate structural market power

in I-SEM, particularly given the weight placed upon them to determine interventions.

The modelled outcomes presented in the consultation paper are largely a function of the input

assumptions and portray (by the RAs own admission) a worst case scenario outlook. The adoption of

mitigations on this basis increases the risk these mitigations impose a disproportionate level of regulatory

burden on ESB, which we would find unacceptable and is not in the long term interests of customers or in

the development of competition in I-SEM.

We have a number of concerns with the approach taken and assumptions adopted to model the DA

market. In summary:

The choice of years modelled

The assumption that there no ESB plant closures

High demand growth scenario used as a base case

The exclusion of any further interconnection from the base case

It is unclear what DSU assumptions have been modelled. If these are based on the Generation Capacity Statement we understand the 2024 forecast was already surpassed in 2015

The impact of interconnector flows under Euphemia not accounted for

Taken together, it cannot be said that these assumptions represent a ‘best estimate’ or ‘central view’. As

such, we do not think it is suitable to use solely as the basis for such significant decision-making.


We provide further thinking on the individual year-on-year DA results below.

The analysis regarding market power in the BM lacks credibility upon which policies should be formed, as

it is based on an assumption that the balancing market is short by 10% (when compared to the Day Ahead

position) in every half-hourly period throughout the year. This is a crude assumption and its fundamental

flaw is that at least 50% of the time (on average) the BM is just as likely to be long as short. This implies

the RSI figures for the BM grossly overestimate the extent of market power.

This overly simplistic assumption for the BM, ignores the fact that the status of the BM is a function of

many factors, including:

Demand forecast error

Wind forecast error

Plant availability

Market participants being short/long relative to the system and each other

The level of incentive (or lack thereof) for participants to balance ahead of gate closure

The availability and utilisation of ancillary services

The extent to which transmission constraints are binding.

Given the complexity of modelling structural potential market power in BM timeframes, we would suggest

that this ex-ante analysis is not useful and is misleading. Notwithstanding the above, we recognise the

potential for local market power in the BM and we see a case for SRMC bidding principles for locational

actions as discussed further below.

2016 and 2019 Modelling Scenarios

The 2016 and 2019 scenarios utilise credible assumptions and have credible outcomes however in

choosing 2019 as a modelled year, a number of material changes to the ESB generation portfolio in 2020

are not reflected. We have included a description of these changes as a confidential separate submission

to our response. We strongly believe that 2020 provides a more informative indication of where the market

will be over the longer term and that 2019 is somewhat misleading in this respect.

Even before taking account of these changes, the modelling illustrates that any dominance concern in

relation to ESB generation will be marginal. Specifically:

The RSI for 2016 and 2019 against a 1.1 threshold, which we believe is appropriate threshold to measure pivotality across the year, is 2% and 4% respectively (estimated from the RSI charts provided in the consultation), notably inside the 5% threshold level.

The market share by volume in 2019 is just over 40%, which is significant given that the European Commission considers there is no presumption of dominance below 40% and the ECJ considers the presumption of dominance at 50% and as noted above our own analysis for 2020 shows a market share of 31.2%, where there is no presumption of dominance.

2024 Modelling Scenario

The 2024 scenario lacks any credibility as a Base Case for the following reasons:

It assumes 10 years of no ESB action – no plant closures and no plant commissionings

It assumes no 3rd Party Builds

It assumes no further IC build (there are at least two highly credible projects looking to commission in the next five years)

It assumes high electricity demand growth scenario


There has never been a 9 year period post deregulation during which these assumptions would have been

valid. Indeed a number of ESB Generation plants have opted for the “limited lifetime derogation” option as

provided for under the Industrial Emissions Directive (IED) which will require that they close no later than

2023 (as detailed in the confidential submission accompanying this response).

In addition, as noted above there is a high probability of further interconnection for Ireland in the period to

2024, with a number of credible projects. On this basis we suggest that additional interconnection should

form part of the base case rather than a sensitivity. Furthermore, a significant expansion of demand side

response, storage and distributed generation can be expected to play an even greater role in market

dynamics than has been accounted for in the 2024 modelling as is already an observable trend in SEM

and other European markets.

As it stands, we would argue that the 2024 Modelling Scenario is not credible and does not add any useful

information to the discussion.

4. MARKET POWER FOCUS AREAS

Given our concerns regarding the geographic scope and modelling outcomes discussed above, it is ESB’s

contention that market power mitigation requirements in I-SEM are less onerous than the RAs’ analysis

would suggest.

Market Monitoring: a robust, properly resourced and proactive MMU is an absolute necessity for the new market and REMIT regulations

FCO: A forward contracting obligation, per se, to mitigate market power concerns is not required and indeed could hinder the development of a liquid forward market. However a measure to provide more continuous liquidity and establish a reliable forward curve is necessary for a well-functioning market. This is required by larger vertically integrated players for the purposes of hedging their assets and setting retail tariffs, and for smaller non-integrated players who need access to risk management products to manage their businesses.

DA/ID bid mitigation: Due to the European nature of these market timeframes and the requirement for a level playing field for all participants, as well as the existing market abuse regulations that exist at a European level (e.g. REMIT), bid mitigation restrictions for the DA/ID markets are neither required or desirable

BM bid mitigation: We accept that market power may be more of a concern in the balancing time frame and is held, albeit on a locational or temporal basis, by a range of participants and not necessarily the larger ones. Consideration therefore of some form of bidding restriction for the BM may be warranted although such restrictions are not without risks to competitive outcomes.

Vertical ring-fencing: Continuation of the vertical ring-fence on ESB cannot be justified by the evidence and the issues identified, and would subject ESB (and ultimately the customer) to undue risks and costs under I-SEM. We would consider this to be discriminatory.

4.1 Market Monitoring

ESB fully supports a robust MMU. Given the more dynamic nature of I-SEM in comparison to SEM we

believe it is important that the unit is adequately resourced for the increased duties it will hold in the new

market, which includes capability to monitor the market with regard to REMIT.

4.2 Forward Contracting Obligation

ESB believes that there is a strong link between the issues of a FCO and vertical integration being

considered in this consultation, and measures that may be implemented to promote forward market

liquidity. We feel it is very important to consider these issues in the round.


We agree that the potential for exercising market power in the forward market is likely to be very limited.

As forward trades will be purely financial in I-SEM the barriers to entry are by definition lower. As the

consultation document notes, European financial regulations such as REMIT, EMIR and MFiD will provide

adequate protection against any suspected market power abuse in the forward market. All I-SEM

participants, including pure financial players, will need to put in place internal governance procedures to

manage the risk of a breach of these regulations.

Therefore, ESB does not consider that structural market power in the I-SEM forward market is a concern

nor is it a concern for the DA and ID markets and on that basis we believe that a FCO to mitigate market

power is unnecessary and indeed (depending on its form) could damage the development of a liquid

forward market.

However we readily acknowledge that the development of a well-functioning forward market is a major

challenge, and key success factor for I-SEM. However the high, and increasing, penetration of intermittent

generation on the system creates a structural limitation on the volume of asset backed ‘clean’ physical

hedges generators can offer to suppliers (as wind is unable to offer a forward hedge). As the volume of

intermittent generation continues to increase and the volume of thermal generating units decrease this

situation is exacerbated. By 2020 there is a real the prospect that less than half12

of the total I-SEM

generation fleet will be capable of providing physical hedges required by up to 90% of the supplied

volume. This is compounded by the fact that PSO-backed hedges which ESB currently and voluntarily

administers on behalf of the CER, will have stopped.

In our view in a well-functioning forward market, participants’ at any time can access the risk management

products they need at a forward price that can be relied on. This is particularly important in the context of I-

SEM, as the new market design will significantly increase the volumetric and balancing risk for market

participants, which introduces a new set of questions relative to SEM (where these risks are more

socialised through the market design) in terms of risk management products that the market may need.

This is also vitally important to promote competition.

We believe that a wider holistic solution for liquidity would be a far more effective means for promoting a

competitive market than a FCO, which would reduce the ability of ESB to provide more continuous liquidity

to the market – analysis conducted by ESB indicates that by 2020 (under current methods for establishing

the forward contracting obligation/DC volumes), very early into the lifetime of I-SEM, mandated forward

contract volumes will have declined to c.2TWh (in reality this points to only 1TWh being available to third

parties given that Electric Ireland receives c.50% of DC volumes under the existing method for

apportioning contracts)13

. Again this is compounded by the fact that PSO-backed hedges will have

stopped. This is in stark contrast with the historic level of regulated forward contracting of c.7TWh.

As explained in section 3.3, once I-SEM becomes part of the IEM, the forward market for participants is

wider. It is expected that the European trend of volumes gravitating towards liquid trading hubs will

continue, with participants in smaller markets using the liquid hubs for the bulk of their forward risk

management, and separately managing any residual basis risk. Larger vertically integrated players who

have sophisticated trading capabilities will be best placed to take advantage of this liquidity source while

small and independent players will likely have to rely on a diminishing volume of clean hedges available in

I-SEM.

This issue cannot be solved through market power mitigation measures (as these too will diminish over

time). The solution lies with those larger vertically integrated players that have the knowledge, expertise

and resources to access liquidity in correlated markets such as the GB market (which is deeper and

12

Assuming c.40% wind, leaves c.60% of the remaining fleet capable of providing hedges. Given scheduling risk it is likely that only a proportion of this 60% can offer hedges. 13

Assumptions underpinning this analysis have been provided to the RAs in separate confidential submission.


adequately correlated to SEM/I-SEM14

) and can in turn offer liquidity to those smaller participants that do

not have a similar trading capability and who will likely be reliant on a diminishing level of clean hedges

available in I-SEM.

As a large player in the market with flexibility in both its generation and supply portfolios (assuming the

vertical ring-fence is removed), ESB acknowledges that it has a role to play in providing liquidity to the

market ensuring that non-integrated participants have access to the flexibility they need to manage their

forward exposures, and balance their near-term positions at reasonable cost. These products will

supplement other hedging instruments available to participants available through the wider IEM.

With the vertical ring-fence removed, discussed further in section 4.5, ESB would be better able to manage

its own risk, as other integrated players can, this will allow us to, in conjunction with other large players,

make available the hedging and risk management products that I-SEM participants will need. Excessive

market power intervention measures may prevent this from occurring, to the detriment of competition, and

ultimately Irish customers.

ESB is willing to be part of a wider solution on liquidity and is willing to ensure, as part of its commitment to

that solution, that forward liquidity is, at the least, not negatively impacted from the re-integration of its

businesses. However ESB is not willing to accept a FCO imposed solely on ESB on the basis of mitigating

market power concerns which are at most residual. This would be disproportionate and run counter to the

objectives of national regulatory authorities set out in the Electricity Directive and the vision for competitive

IEM operating across the EU as outlined earlier in this paper.

4.3 Day ahead and intraday market bid mitigation

The I-SEM DA and ID markets will be exclusive and cross-border in nature and as such all I-SEM market

participants trading in these timeframes must comply with the many rules and regulations they fall under.

The raison d’etre of making these extensive changes is to facilitate market integration supported by

efficient interconnector flows. If prices in I-SEM are established on a different basis than the rest of the

IEM (as would be the case with DA and ID bid restrictions), the whole endeavour is undermined and could

deliver inefficient interconnector flows. There is a real risk that any ex-ante interventions applied in these

markets may place I-SEM participants at a disadvantage relative to other participants in this wider market

who are not subject to such rules. This would be disproportionate and should be viewed as a regulatory

failure.

For these reasons caution should be applied before deciding to intervene ex-ante into the DA and ID

markets. As discussed below, an appropriately regulated BM should be sufficient to guard against possible

exploitation of market power in the DA and ID markets since parties effectively have the option of trading

through the BM via imbalance settlement if DA and ID prices were being manipulated (which in the light of

REMIT would be an extremely risky and potentially illegal strategy). It is of paramount importance that any

decision to intervene ex-ante is thoroughly scrutinised, based on robust empirical evidence and (both as a

matter of law and a principle of good regulation) must be proportionate. Any measure should satisfy the

Irish Better Regulation Principles to ensure the right competitive balance that delivers optimal outcomes for

customers. The RAs’ commitment to evidence-based decision making is paramount throughout this

process. We see the move to I-SEM as a significant market change, and any measures need to be

considered in light of this new market design and wider European regulatory framework, and not just a

simple roll-over of existing arrangements from SEM.

14

The extent of the correlation between SEM and BETTA is also recognised in the latest SEM MMU Report, Q3 2015 – “The profile and trend of historic market prices in both markets is broadly similar, and there is a high degree of correlation between the two.”


Given the above, ESB considers that only an ex-post assessment and monitoring of bids into the DA and

ID market is viable. In terms of whether bidding principles based on SRMC, conduct/performance

assessment against SRMC outcomes, or licence condition to prevent undue deviations in prices are

adopted, the fact remains that flexibility in bidding must be permitted, while any deviation from expected

outcomes will be assessed on the basis of a SRMC outcome (which takes into account opportunity costs

and risk premia).

ESB considers, however, that where ambiguity or the potential for ambiguity exists that clarity is important

and so believe that a clearly defined set of guidelines (with flexibility enshrined in them) would aid all

market participants.

4.4 Balancing market bid mitigation

The analysis conducted by the RAs, even with what we believe are fairly conservative assumptions,

demonstrates that there is unlikely to be market power in the forward, DA and ID market. The BM is,

however, the one area where there may be legitimate concerns regarding the potential to exercise market

power, (notwithstanding our previous comments related to the sophistication of the modelling for the BM

market power assessment). This issue is not specific to I-SEM, and in most equivalent markets

internationally there is the potential for participants to exercise locational or temporal market power, and

not necessarily just the larger players.

In most other European markets, ex-post measures have been deemed sufficient to tackle this issue,

further strengthened now by the REMIT provisions. In GB, an explicit licence condition (pre-dating REMIT)

was implemented to prevent abuse of market power behind transmission constraints.

Whilst we believe that ex-post regulation, implemented through an enhanced MMU, should be sufficient,

we understand the case for explicit SRMC-based bidding principles for balancing actions required to

alleviate transmission constraints, or for other types of balancing actions where competition may be

limited. These principles must recognise opportunity costs and risk premia associated with the risk of

outage whilst delivering balancing actions.

We note that under such an approach, some plant which may be required for managing transmission

constraints may fail to clear in the capacity auctions, and be unable to cover the remainder of their fixed

costs by bidding in scarcity into the BM. For these plant, additional bilateral contracts with the TSO may be

required to prevent them exiting the market.

There is also the broader question of whether SRMC-based bidding restrictions should be extended to all

bids in the BM, including energy actions used to set imbalance prices. This would be a robust measure to

remove any residual concerns regarding abuse of temporal market power, but would potentially have

some negative consequences for the wider market, including:

A BM that is less ‘volatile in terms of price (i.e. without some element of scarcity pricing) will fail to send sufficient balancing responsibility incentive to suppliers. Ultimately this is in nobody’s interest and is not good for the integrity of the market. For example, by removing strong dynamic price signals it may slow the development of demand side response, which itself would help to alleviate market power concerns.

Balance responsibility incentives are already somewhat dampened by decisions made in the CRM work stream for a hybrid RO Reference price. This decision serves to “…provide suppliers with a hedge on BM and ID market price exposure…”.

It is not certain how or whether SRMC formulaic/prescriptive bidding would comply with the IEM’s network code on Balancing, which will seek to apply a common merit order of balancing products between Coordinating Balancing Areas. Level playing field concerns may be voiced if one set of parties to the common balancing regime are required to bid on a short run cost basis only, whereas others may be bidding in scarcity and inframarginal rents. It could also ultimately lead to I-SEM customers subsidising balancing actions for other European markets.


Finally we have questions over how an SRMC regime in the BM, where generators cannot bid in their own view of scarcity and future inframarginal rents, will operate in the context of the CRM. Under the new CRM a plant has no guarantee to receive an RO contract (capacity payment) but such plant may actually make a positive and meaningful contribution to security of supply. Whether SRMC bidding is appropriate in such circumstances should be assessed further.

4.5 Removal of ESB’s vertical ring-fence

Our primary concern regarding the market power mitigation measures under consideration is the

continuing application of the vertical ring-fence between ESB’s generation and supply businesses. In this

regard, we would draw your attention to the following statutory objectives, duties and functions of the SEM

Committee:

– The principal objective of the SEM Committee in carrying out its functions under section 8A(4)

of the Electricity Regulation Act 1999 (as amended), is to protect the interests of customers of

electricity in the State and Northern Ireland supplied by authorised persons, wherever

appropriate by “promoting effective competition between persons engaged in, or in commercial

activities connected with, the sale or purchase of electricity through the Single Electricity

Market.15

”

– The SEM Committee must carry out its functions in a manner that is best calculated to promote

efficiency and economy on the part of authorised persons (i.e. licensed market participants);16

– In carrying out its functions, the SEM Committee may not discriminate unfairly as regards terms

and conditions between authorised persons17

The continuation of asymmetric market power mitigation measures targeted at ESB, and in particular, the

imposition of vertical ring-fencing in respect of ESB’s generation and supply businesses, can no longer be

justified. It does not address the two primary areas of concern under I-SEM, namely limiting any market

power concerns in the BM and providing continuous liquidity and a reliable forward price.

The ring-fencing measures are contrary to the requirement not to discriminate unfairly and do not promote

the objectives of efficiency and competitiveness, as they require ESB to trade and operate in a

burdensome and inefficient manner which impedes its ability to compete with generators and suppliers of

significant scale, who are not subject to any such ring-fencing requirements.

Vertical integration of generation and supply activities is a common organisational structure in electricity

markets. This is the case in GB and Europe and under I-SEM, ESB will soon be competing against a

number of vertically integrated within the IEM. A number of these firms, Centrica and SSE, already operate

within the SEM.

Vertical integration provides efficiency benefits but may reduce transparency which is an area of concern

for regulators. The recent Energy Market Investigation by the CMA in GB explored the costs and benefits

of vertical integration and found little evidence of harm suggesting there was no case for business or legal

separation of the vertically integrated companies, despite calls in some quarters for such remedies. It is

clear that the CMA was not even close to considering business separation. Although market concentration

is different in the I-SEM context, it raises the question as to whether an equivalent investigation in the Irish

market would have required the imposition of a vertical ring-fence on ESB.

Prior to 2012, ESB had separate regulated and “unregulated” generation activities which were subject to

horizontal ring-fencing requirements. The RA’s 2012 decision permitted ESB to horizontally integrate each

15

Section 9BC(1)(c) Energy Regulation Act 1999 as amended 16

Section 9BC(4)(a) Energy Regulation Act 1999 as amended 17

Section 9BC(2)(e) Energy Regulation Act 1999 as amended


of its generation business, allowing the previously separate businesses to share information and to jointly

trade in the market. ESB vertical integration (i.e. integration between generation and supply activities) was

disallowed at that time for four reasons18

:

The SEM spot market (gross mandatory pool) showed a high level of market concentration when measured with the HHI

Forward market power would be more significant than the status quo, which could be disruptive to other suppliers and have a negative impact on competition in wholesale and retail markets

There could be information advantages that would benefit Electric Ireland and have a negative impact on competition in both the wholesale and retail markets

CEPA was of the view that full vertical integration was unfavourable as it could damage competition and the replacement of a structural remedy with a likely less efficient and or effective regulatory remedy.

The above are clearly all costs associated with market power concerns, whereas the current consultation

states that “if it were clear that the potential benefits (i.e. cost savings) from allowing incumbents to

vertically integrate clearly outweighed the costs associated with, say, any negative impacts on forward

liquidity or the risk of foreclosure, then allowing vertical integration would have a justification.“

These concerns both from the 2012 Decision and the current consultation are discussed further below.

4.5.1 The Benefits (i.e. Cost Savings) from Vertical Integration

ESB currently carries a range of additional costs arising from the continued imposition of business

separation restrictions. ESP Consulting in a report for DECC cited the ESB ring-fence as a case study,

stating that although unable to “access any public domain data on the cost of implementing and managing

the ring-fence obligations, it is very clear that they are considerable”.

In the same report ESP also highlight a number of generic benefits from vertical integration. These include

“diversification along the value chain, collateral-free off-take and sourcing channels within the business, a

relatively balanced market risk position, advantages in the short-term market relating to balancing and

shaping, and a tendency towards higher credit/debt ratings due to perceived higher stability”. Stating that

“Actions which constrain vertical integration are disruptive to these benefits and therefore disproportionally

increase costs and there is no guarantee that such interventions will lead to sustainable improvements in

liquidity”19

.

ESBs perspective on these benefits can be summarised as:

Better Risk Management Capability

o A single risk management function reducing costs

o Reduced credit margins

o Less requirement for internal compliance function

Reduced Wholesale Price Premiums

o Avoid both a trading and supply premium to wholesale costs

o Avoided brokerage fees paid to a third party trade platforms e.g. Tullett Prebon

o Smoother wholesale costs aligned with more liquid gas / CO2 markets

More Innovative Tariffs

o Offer more competitive shaped products to customers e.g. residential 2 year fixed price

18

SEM-12-002 p. 4 19

GB Wholesale power market: Liquidity Intervention Options, ESP Consulting for DECC, May 2013, p 11 and 113.


o Domestic customers less exposed to lower liquidity in peak production due to increase in wind

o Ability to adjust new product offerings quicker

Greater Competition

o Economies of scale, no duplication of Trading teams/IT systems / Business Processes

o Balance sheet strength and credit rating

o More sophisticated trading capability & experience

The additional costs will increase significantly in I-SEM if the ring-fence is retained, as ESB is either faced

with the choice of exposing Electric Ireland to an increased level of risk (which will ultimately lead to

additional costs) or acquiring additional (duplicate) resources and systems at significant expense, for its

standalone supply business to trade in I-SEM. Electric Ireland is currently not geared to trade in a dynamic

and volatile market such as I-SEM.

The removal of the ring-fence will ensure that unnecessary new costs are avoided. Avoiding these costs

will afford ESB greater flexibility in pricing appropriately to market conditions with the knock on benefit for

customers. Our current estimates of the inefficiencies that are currently imposed on ESB due to ring-

fencing, as well as future inefficiencies that will be incurred if ring-fencing is retained are summarised in

the Table 2.

Table 2 Estimated Costs/Inefficiencies Imposed on ESB from Ring-fencing

Description €

Existing Inefficiencies

(Replication in staff, functions and systems, ineffective risk management

arising from an inability to trade one position for the group)

12m pa

Future Avoidable Inefficiencies

(Additional resources and systems required to allow Electric Ireland

manage its risk in I-SEM)

14m pa

Annual Costs Arising from Continuation of Ring-Fence in I-SEM 26m pa

Additional (avoidable) capital cost for Electric Ireland in I-SEM if ring-fence

is retained

€17m

A decision on the continued application of the vertical ring-fence in I-SEM is urgently required in order to

Allow Electric Ireland sufficient time to implement the required processes and systems, for I-SEM commencement (while remaining compliant with public procurement rules).

Avoid stranding an additional €17m spend which will ultimately be borne by the customer.

The elimination of the ring-fence would provide an immediate and lasting benefit for all electricity

customers. In addition, its removal would help to ensure that competition is founded on a sustainable

structure, where rivals need to work to create discounts on behalf of customers, rather than benefiting from

the inefficient structure of the incumbent imposed by regulatory decree.

4.5.2 Vertical Integration, Forward Liquidity and Foreclosure

4.5.2.1 Forward Liquidity

The second reason cited by CEPA for disallowing vertical integration was based on the concerns about

forward market liquidity in the SEM. Specifically, CEPA noted that ESB may not have the incentive to offer


forward products or to offer them at high prices to all suppliers or to offer low prices to Electric Ireland and

high prices to other suppliers. Any of these outcomes would have an adverse impact on retail market

competition and ultimately on the I-SEM customer.

This view persists into I-SEM, given that the SEM Committee has stated in the market power consultation

paper that vertical integration would have a justification “if it were clear that the potential benefits (i.e. cost

savings) from allowing incumbents to vertically integrate clearly outweighed the potential market power

costs associated with, say, any negative impacts on forward liquidity or the risk of foreclosure…”. Whilst

ESB understands the RAs rationale in this respect, it is clear from the market power analysis that a

continuation separation of generation and supply within ESB is not warranted and hence if the RAs are of

the view that customers are better served through maintenance of ring-fencing arrangements, then it

follows that the very same arrangements should apply to all participants in the market place in order to

ensure adequate liquidity, as to do otherwise would be discriminatory.

As noted in the section on forward contracting obligations related to market power mitigation measures,

ESB is willing to be part of a wider solution on liquidity and is willing to ensure, as part of its commitment to

that solution, that forward liquidity is, at the least, not negatively impacted from the re-integration of its

businesses. However, a general concern about forward liquidity is not a valid basis on which to impose

asymmetric ex-ante measures on ESB, nor is vertical ring-fencing a necessary or appropriate means by

which to achieve liquidity in the market.

A feature of any well-functioning market is a forward market where participants are able to access at any

time the hedges they need at a forward price that can be relied on. This is to the benefit of all participants,

including larger vertically integrated players for the purposes of hedging their assets and setting retail

tariffs, and for smaller non-integrated players who need access to risk management products to manage

their businesses. Given the structural issues with liquidity in the market, ESB would be willing to support a

holistic approach for promoting liquidity in conjunction with other larger players. This would be a far more

effective means for promoting a competitive market than a FCO or retaining the vertical ring-fence, which

would reduce the ability of ESB to provide more continuous liquidity to the market – analysis conducted by

ESB indicates that (under current methods for establishing the FCO/DC volumes) by 2020, very early into

the lifetime of I-SEM, mandated forward contract volumes will have declined to c.2TWh (in reality this

points to only 1TWh being available to third parties given that Electric Ireland receives c.50% of DC

volumes under the existing method for apportioning contracts)20

. This is compounded by the fact that PSO-

backed hedges which ESB currently and voluntarily administers on behalf of the CER, will have stopped.

Ensuring there is sufficient continuous liquidity in the forward market and a reliable forward price should be

the main concerns for the SEM Committee (and ESB contends it is the primary risk to the successful

implementation of I-SEM given the structural deficit in hedgeable generation in I-SEM) and that the

provision of forward volumes on the basis of a residual and declining market power concern is not a

sustainable outcome. Such an outcome places the market under a high risk of failure (particularly for

smaller players), where there is an insufficient ability to manage risk.

ESB considers that the liquidity it can offer to third parties will be greater than the prospect envisaged from

a market power FCO (and potentially a distinct and separate liquidity mechanism) if a more progressive

and holistic approach towards forward liquidity is adopted by the SEM Committee, e.g. with a solution

similar to the Secure and Promote measures adopted by OFGEM, coupled with the removal of its ring-

fence vertical integration. We also contend that there would need to volume limits to ensure that the

parties subject to these obligations are not unduly exposed.

4.5.2.2 Foreclosure

One of the primary concerns regarding vertical integration is the foreclosure of the market by the vertically

integrated firm. The CMA in GB in its recent Energy Market Investigation has conducted analysis into the

20

Assumptions underpinning this analysis have been provided to the RAs ina separate confidential submission.


ability, incentive and effect of vertically integrated firms using their position in one market to harm

competitors in another market (foreclosure). The analysis considers two types of foreclosures, both of

which are standard issues to consider in the context of vertical integration and are also pertinent to vertical

integration in a SEM/I-SEM context.

Customer foreclosure: Involves a vertically integrated supplier causing harm to upstream competitors by strategically reducing their ability to sell their output. In electricity, these upstream competitors are independent generators.

Input foreclosure: Involves a vertically integrated firm taking action in an upstream market to disadvantage participants in a downstream market, i.e. independent retailers. We consider two possible mechanisms: one through increasing wholesale electricity prices, and one through trading and liquidity

On Customer Foreclosure the CMA found that:

Most of the vertically integrated energy firms as net purchasers of electricity are likely to offer a potential alternative route to market to any foreclosed generator (in the absence of a coordinated foreclosure strategy).

Independent suppliers represent not insignificant volumes in domestic and non-domestic supply. This means that they provide a significant alternative route to market for potentially foreclosed generators.

Independent generators represent significant market share, and therefore even a successful foreclosure strategy would have limited impact on customers if it affected only a proportion of independent generators.

In summary therefore, the CMA found that vertically integrated firms do not have the ability to foreclose

independent generators and that it was questionable as to whether there is an incentive to foreclose, or

whether there would be any effect on end customers in any event. Given that all three conditions must be

met for customer foreclosure to be viable, the CMA did not find any reason to consider this issue further.

On Input Foreclosure the CMA found that:

The benefit to the withholding firm depends on two factors. First, how many switching customers does it gain? Second, what margin does it earn on those customers? The diversion of customers from independent suppliers will generally not be wholly to the foreclosing vertically integrated firm. Furthermore it can be expected that the customers who are diverted will be primarily the most price elastic customers, and that margins on those customers will be low. Therefore, the gain from foreclosure will not be large.

Even generators with relatively low market shares may be able to influence wholesale prices by withholding generation capacity. However in practice, the ability to affect wholesale prices significantly generally occurs when demand is close to the point at which there is a shift between technology types of the marginal unit of generation, and withholding can change the price-setting technology – for example, shifting it from coal to gas. However, many of these opportunities arose because of the increase in spread between coal and gas prices that took place in 2013, so for a withholding strategy to be consistent with forward trading, the parties and the market in general would need to have anticipated the increase spread between gas and coal prices in 2013, and the CMA consider this to be relatively unlikely. Beyond that shift, any further price rises are relatively small and require withholding relatively large volumes; which are generally unprofitable for the generator.

The size of any gain depends on how many customers switch to the foreclosing vertically integrated firm (or are deterred from switching away from it) and the margins earned on those marginal customers.

The ability and incentive to exploit the opportunity is hampered by uncertainty about demand and wind output. If a generator does not know with certainty when it will have the ability to shift


price significantly, it will have to withhold capacity more often in order to achieve price effects, and will incur a loss when the price does not shift significantly.

In order to have the ability to withhold, the generator either will have to avoid forward contracting the relevant output, thus incurring risk that could have been avoided, or will have to acquire a costly reputation for withholding even when its forward position would incentivise it not to do so.

There is a substantial lag between introducing the strategy and seeing an effect on independent suppliers, and therefore a degree of risk which reduces the profitability of the strategy – because market circumstances may change between the period in which the generator withholds and the period in which expectations affect forward prices.

In the standard economic model of input foreclosure, the vertically integrated firm will sell to other firms at the raised price while its retail arm continues to purchase the upstream arm’s output, so the retail arm does not face higher costs. However, in the electricity sector in practice the retail arm will purchase from other market participants (this could be for a number of reasons, e.g. to meet customer shape requirements). Therefore, the retail arm cannot entirely avoid the increase in wholesale prices, so its costs increase and the retail margin available (i.e. the gain from foreclosing) is consequently reduced.

Finally capacity withholding could be considered a market abuse and therefore punishable under REMIT. If detected, penalties can be severe, meaning that gains from withholding would be more than offset.

Given all of the above the CMA has found it unlikely that vertically integrated firms would have clear

incentives or the ability to disadvantage independent suppliers through foreclosure.

We are confident that the issues and findings of the CMA on vertical integration are relevant in I-SEM and

as such the findings, should be of prime consideration for the I-SEM Market Power work stream.

From an I-SEM perspective the SEM Committee has added comfort from two additional points, namely:

On customer foreclosure, ESB is structurally short and will continue to be a net purchaser of electricity and therefore will provide a route to market for independent generators

On input foreclosure, the Irish Commission for Energy Regulation (CER) has the option to re-introduce regulation of ESB’s retail business should they conclude that market dynamics have changed such that competition and customers in a given market have been negatively impacted.

In addition, analysis conducted by ESB regarding plant withholding / strategic bidding strategies at the DA

stage results in either negative or only marginal gains. The risks from such an approach (due to factors

such as REMIT and the level of uncertainty due to high wind generation levels) far outweighs the small

benefits that could be gained and demonstrates that such a strategy would not be viable. We outline our

analysis in more detail in a separate confidential submission attached with this response.

Finally, concerns over input foreclosure should give added incentive to the SEM Committee to ensure that

there is sufficient continuous liquidity in the forward market and a reliable forward price – a reliable forward

curve becomes the benchmark against which all trades can be assessed (including for vertically integrated

participants) and allows regulators to scrutinise whether input foreclosure has occurred. This is evidenced

in GB where analysis of market abuse conducted by the CMA was against the publicly quoted BETTA

forward curve.

4.5.3 Vertical integration and informational advantages

The third reason relates to concerns that vertical integration provides Electric Ireland with an information

advantage relative to other suppliers that operate in the SEM. CEPA noted a concern that Electric Ireland

could have an advantage over other suppliers from knowing information about ESB generation portfolio or


other supplier’s contracted positions and if it were to act on that information it would have a negative

impact on competition and customers.

Market integrity and transparency is of paramount importance for well-functioning energy markets and for

promoting the confidence of market participants and customers. CEPA’s noted concerns were part of the

rationale underpinning the development of REMIT. REMIT is a sector-specific legal framework for the

monitoring of wholesale energy markets and applies to all energy market participants, including those that

are vertically integrated and those that are not. The objective is to ensure that customers and other market

participants can have confidence in the integrity and transparency of market prices and to detect and to

deter market manipulation.

In addition to REMIT, the Transparency Regulation21

makes European electricity market information more

precise and comparable. It is mandatory for each TSO to submit fundamental information related to

generation, load, transmission and electricity balancing to ENTSO-E which is then published on a central

platform22

.

Since CEPA’s report on vertical ring-fencing, Member States have adopted the measures necessary to

effectively implement REMIT at a national level, the necessary procedures have been put in place by

ACER, and the Transparency Regulation has been adopted. These measures are relatively new in the

context of the SEM market power mitigation measures. Whilst the vertical ring-fence may have served a

purpose in mitigating CEPA’s concerns up until REMIT and the Transparency Regulation came fully into

effect in Member States, the continuation of the vertical ring-fence to address this information concern is

clearly no longer necessary. Whilst CEPA acknowledged the introduction of REMIT at European level, it

can now be seen how the measures taken to give effect REMIT provide a high degree of transparency in

practice, and that this is proving an effective tool to target market abuse and for authorities to take

enforcement action.

4.5.4 Vertical integration as a more efficient structural remedy

The final reason raised by CEPA in 2012 recognised the benefits of a simpler regulatory regime. CEPA

claimed the removal of the vertical ring-fence would require ‘significantly more regulatory oversight and on

a more frequent basis’. Whilst this may have been the case at the time of the RAs’ decision in 2012, we

have shown both in this section and in section 3 above that there is clear duplication between the vertical

ring-fence and other mitigations of any residual market power, including those which have been introduced

in the interim through European law, suggesting that the continuation of the vertical ring-fence is manifestly

disproportionate and is not necessary. This ex-ante regulatory intervention simply cannot be justified any

longer when one has regard to the changing regulatory landscape, ESB’s declining market shares and the

increase in competition from large vertically integrated players.

Removing the vertical ring-fence would have little impact on the regulatory protection for customers, and

yet would allow ESB to compete more effectively with other European vertically integrated players. It would

also be consistent with a maturing of competition in the SEM, and an acknowledgement of the importance

of new European energy market regulations.

As previously noted it is vital that the potential for market power under I-SEM is carefully evaluated, and

any mitigations are proportionate and are consistent with the wider IEM of which I-SEM will be part. As

part of that assessment we believe there is a compelling case to allow the re-integration of ESB’s

generation and supply business units, for the following reasons:

With the introduction of, and integration with the IEM, the relevant markets for assessing market power become wider. Greater convergence across markets will provide I-SEM participants with more options for managing risk. The continuation of ESB’s vertical ring-fence

21

Regulation (EU) 543-2013 Transparency Regulation 22

https://transparency.entsoe.eu/

https://transparency.entsoe.eu/


is inconsistent with this future vision of integrated players and independents competing across the IEM, and is a disproportionate intervention which prevents ESB from competing on a level playing field in this wider market.

There is a significant difference between having market power, and abusing it to the detriment of customers. The CMA’s recent Energy Market Investigation makes clear this distinction, and disproves several theories of harm related to vertical integration.

Any market power mitigations must be considered in the context of protections already provided through licences, the market rules and wider European competition law and regulations, such as REMIT. To dismiss REMIT as not being “sufficient to protect customers and competitors from the exercise of market power, given the level of structural market power forecast for I-SEM” is short sighted and fails to take account of the impact this regulation will have on behaviour. Ex-ante forms of regulation, such as the vertical ring-fence risk trying to address concerns which are covered elsewhere, and can potentially thwart the development of competition which result in regulatory failure.

I-SEM will, by virtue of its design, impose greater risk on market participants. With the ring-fence removed, ESB will be better able to manage its own risk, as other integrated players can, to the benefit of its customers, and to make available the hedging and risk management products that non-integrated players will need. Excessive market power intervention measures may prevent this occurring, to the detriment of competition, and ultimately I-SEM customers.

CER and the Utility Regulator have in place very onerous reporting obligations on generators and suppliers in SEM. Since 2012 generators have been required to provide financial performance reports annually to regulators on revenues, operating costs and earnings/profitability on a station by station basis in alignment with regulated accounts reporting. The RAs can review generator financial performance in order to inform policy decisions and this is considered a key transparency tool for the market. For suppliers, the Retail Energy Market Monitoring (REMM) provides detailed insights and transparency to both Regulators in SEM on the level of retail activities contributing to commercial and financial performance. This licence obligation, which commenced in the second half of 2015, provides, monthly, quarterly and annual detailed breakdowns of a range of indicators including make up of pricing for the full range of tariff types, retail margins (including breakdown of wholesale components), payments, arrears, and complaints across the total customer base and related business and residential segments. These obligations have increased significantly since the 2012 decision on vertical integration, and should provide the RAs with a signficiant level of transparency and comfort in I-SEM.

As has been set out in this paper, there is no case to justify the continuation of the ring-fence and it is an entirely disproportionate measure to address a declining market power concern. The risks of interfering with ESB’s ability to compete effectively in I-SEM and the greater IEM far outweigh any benefits of continuing the operation of the ring-fence.

4.5.5 Summary of Vertical Integration Arguments

In light of the market power assessment framework conducted by the RAs the continuation of ESB’s

vertical ring-fence under I-SEM can no longer be justified when one has regard to the changing regulatory

landscape, ESB’s declining market shares and the increase in competition from large vertically integrated

players. It would also appear at odds with allowing other vertically integrated players that ESB will compete

against in the IEM, and a number of which already operate in the SEM, to operate without such

restrictions. Indeed, this risks distorting competition in I-SEM and the IEM. Further, a vertically integrated

ESB would be able to realise efficiencies that can benefit all I-SEM customers, and would make it better

able to provide risk management products to the wider market helping to promote competition and to

ensure I-SEM develops into a successful and vibrant market.


APPENDIX 1: RESPONSES TO CONSULTATION QUESTIONS

In this section we provide detailed responses to the questions posed in the RAs’ consultation paper. In

sections 2-4 above we address a number of aspects of the consultation questions. Where that

commentary is applicable we have cross-referenced the question responses to the relevant section above.

Chapter 2

Do you agree with the policy developments and trends identified (above) as potentially impacting

on an I-SEM market power mitigation strategy?

Increasing wind penetration is a key market trend, with a number of fundamental impacts in this context, including:

It is driving the I-SEM market to be structurally short, which is in turn driving new risk management approaches via GB proxy hedges (and already demonstrating a wider forward market definition than that being proposed by the RAs)

A reduction in ESB’s overall generation market share

An increase in the importance of flexibility (and potential pivotality of flexible assets)

A consequence of ESB having a smaller market share is a reduction in the volume of DCs (linked to HHI) as a driver of forward market liquidity

We would add a number of further comments on the policy developments identified:

New entry from large and integrated players has changed the competitive landscape considerably

A number of credible new interconnector projects have a high likelihood of proceeding in the coming years and this will further reduce any ability that ESB has to exercise market power in the physical markets

We agree that demand side participation in spot markets can drive greater elasticity and further reduces the ability to exercise market power while also reducing the need for such measures

The introduction of REMIT is a significant reform in European energy markets, and the strength of the associated disclosure and enforcement provisions in terms of impacting behaviour should not be underestimated

Are there other factors not identified here which you consider relevant?

I-SEM will introduce new risks for market participants to manage, and as such we would suggest that

liquidity and availability of products should be the chief concern for RAs looking to drive increased

competition. With market coupling, I-SEM will become more integrated with GB and the wider European

market, both in financial forward markets and physical spot markets over time. Market participants will

need access to new risk management products, and ESB and other larger players with more sophisticated

trading capabilities will have a role in providing these products to the market.

We believe there is a strong linkage between the issues and proposed measures discussed in this

consultation with those associated with liquidity and vertical ring-fencing, and hence consider that

decisions should be taken in the round. A series of discrete interventions to address each issue identified

individually risks introducing pancaking of measures, and a disproportionate level of overall intervention

with negative consequences for the development of the market.


Chapter 3

Do you agree with the proposed appropriate markets/trading periods for assessing market power

in I-SEM’s energy and financial markets?

At a high-level, these distinctions on product and market timeframes for the purposes of assessing market

power make sense.

On the physical markets, as the paper notes there will be varying degrees of supply availability in different

timeframes, whether driven by generator or transmission constraints. It therefore makes sense to first

conduct the market power assessment for each market separately, while taking into account the strong

interactions between the various markets so as to avoid duplication or ‘pancaking’ of measures /

interventions.

We agree that the relevant product in forward markets should be financial-only products, and that the

assessment of market power should be conducted on this basis.

Do you agree with the proposed geographic scope of the proposed markets/trading periods?

Please see section 3.3

Chapter 4

Do you agree with the proposed definition of competitive behaviour and pricing in I-SEM?

The consultation document defines competitive offers as “…equal to short run marginal cost (SRMC),

where SRMC includes relevant opportunity cost”. While this mirrors the prevailing philosophy under the

SEM, we would make three comments on its applicability or desirability under I-SEM:

1. It is as yet unclear where fixed cost recovery might occur across the energy, capacity and DS3 markets in I-SEM and any decision to impose a requirement such as SRMC behaviour and pricing must be considered in the wider context.

2. This philosophy may require further consideration in the context of integration with the European electricity market under I-SEM. Pricing down to SRMC under I-SEM could distort cross-border flows where there is a different pricing philosophy in the adjacent market. For example, as scarcity pricing is allowed in the GB market arrangements, we may expect SRMC pricing in I-SEM to drive exports to GB during tight winter periods. This could in turn have security of supply implications for Ireland. It highlights the importance of harmonisation of market arrangements as European integration increases (an issue which is currently on the European Commission agenda in the context of individual member state capacity mechanisms).

3. It should be recognised that the use of SRMC pricing in the wholesale market can affect the mix and capability of plant coming onto the system. In particular, with SRMC controls, the lower volatility inherent in prices close to real-time may under-value flexibility both from the generation and demand side. Conversely, SRMC pricing may insulate intermittent generation from the real-time costs of their intermittency. This is not necessarily a competitively neutral outcome in the long-term, and while other mechanisms (such as DS3) could procure the required flexibility, there may be reduced innovation and thus a loss of dynamic efficiency. This may result in a perverse outcome that dampens the emergence of an active demand side.

We provide further comment on the individual proposed interventions in section 4 and below in response

to the questions in chapter 8 of the consultation paper.

Do you think that the suggested examples in which market power can be exercised in I-SEM

captures the relevant issues?


As mentioned in section 2.1 below is our high-level assessment of the ex-ante and ex-post intervention

against each of the Irish Better Regulation Principles. On the basis of this analysis we believe caution

should be applied before deciding to intervene ex-ante and that any decision to do so should be

thoroughly scrutinised based on robust evidence as well as satisfy these principles.

Effectiveness

Removing a firm’s ability to cause a market failure through ex-ante intervention provides the regulatory

body a high degree of certainty that the potential for market failure and resulting customer detriment is

mitigated. This can be particularly important if governments or regulatory bodies want to demonstrate that

they have solved a particular problem.

In contrast, ex-post interventions aim to deter or prohibit certain market behaviour. This in itself does not

mitigate the potential for market failure. It is the corresponding obligation power for regulatory bodies to

either continuously monitor a market and/or to investigate and enforce any suspected breach that acts as

a powerful deterrent. A firm could face a substantial monetary fine, face considerable reputational harm or

ultimately lose its operating licence. This threat of enforcement can thus drive a behavioural change in the

interests of customers.

Ex-post interventions leave some of the interpretation of acceptable behaviour to the market participant.

Hence, it can be more ambiguous than an ex-ante intervention but also more wide-reaching. One potential

advantage of this is that the regulatory body does not need to impose rules that may have unintended

consequences, including imposing unnecessary costs on participants, for little customer benefit and which

risk thwarting competition and innovation. To address the potential for ambiguity, regulatory bodies often

issue guidelines to inform participants what is acceptable conduct (or indeed companies look to formulate

ex-ante principles to guide behaviour and thus minimise the risk of enforcement action).

Effect on competition and innovation

An ex-ante intervention in its simplest form is a distortion to a market structure, which has the potential to

harm or impede the development of competition and/or remove the incentive to innovate. This can lead to

sub-optimal outcomes for customers, especially in the long-run. Therefore the risk of regulatory failure is

higher which suggests that careful analysis is necessary before deciding to intervene ex-ante. Indeed, for

an ex-ante intervention to be effective it must be flexible and reviewed and updated regularly to ensure it

evolves as the market conditions evolve. By contrast, ex-post intervention allows markets to work giving

competition and innovation that opportunity to produce an efficient outcome. At the same time it gives

regulatory bodies sufficient powers to investigate and enforce any foul play which safeguards customers

from any detrimental effect of market failure.

Regulatory certainty

An ex-ante intervention can provide participants with greater certainty of revenues, costs or any applicable

technical standards. This may help participants secure planning permission, financing or a licence. This

predictability can help to progress societal objectives by providing greater investor confidence, and

promoting new entry. However, if poorly designed, the ex-ante intervention can have the opposite effect,

due to regulatory failures.

Regulatory certainty is harder to achieve through ex-post intervention. As the nature of the intervention is

after an event it always involves an element of uncertainty for the each participant (although this

uncertainty will apply equally to all participants). That said, regulatory bodies can act to mitigate the

uncertainty by issuing guidelines.

Risk of regulatory failure

A regulatory failure is a situation where an intervention by a government or regulatory body leads to an

inefficient allocation of resources, which results in a sub-optimal outcome for customers. There are a


number of potential regulatory failures that could come about as a result of intervention to mitigate market

power (either ex-ante or ex-post). These include:

The intervention does not arrive at the socially optimal solution to the market failure it is trying to solve due to information asymmetry or regulatory capture

The intervention is poorly designed meaning it fails to achieve its objective; or does so at a high cost; or the intervention leads to unintended consequences

The intervention may be poorly implemented or enforced

The intervention becomes obsolete and as the policy environment around it evolves

Any type of intervention faces the risk of regulatory failure. We would argue that ex-ante intervention is

more susceptible to this risk due to the informational and analytical challenges associated with determining

the impact of a market failure. Moreover, as ex-ante interventions are by definition more reliant on

regulatory judgement, the risk of regulatory failure is likely higher. The regulatory risk of ex-post

intervention is primarily the challenge of the case-by-case nature of investigations and enforcement.

Regulatory burden

Ex-ante interventions often impose stringent rules and requirements on participants and thus add to the

regulatory burden. On the other hand, such requirements can make it easier to demonstrate and report

compliance which can reduce the regulatory burden.

Finally, under I-SEM the Irish market will become part of the wider IEM, which has less ex-ante regulation

and a greater focus on competition and ex-post monitoring and enforcement. There is a risk that any ex-

ante interventions applied to Irish participants may put them at a disadvantage relative to other participants

in this wider market who are not subject to such rules.

Do you agree that the potential for market power abuse in I-SEM appears to be weaker in the

forward financial market compared to the physical markets?


Do you agree with the implications for market power arising from interactions between the

physical markets, CRM, FTRs and DS3 System Services as shown above?


Chapter 5

Do you agree that these are the appropriate metrics to identify market power ex-ante and ex-post in

I-SEM?


Are there other metrics that you consider should be applied?

Please see sections 3.2 and 3.4

Chapter 6

Do you agree with the approach taken by the RAs to modelling market power in I-SEM?



Do you agree with the conclusions for I-SEM market power that have been drawn from the

modelling results?


Chapter 7

Do you agree with the SEM Committee’s view on the effectiveness of each of the SEM market

power mitigation measures?

In Table 3 below we provide our own summary of the various interventions in place under SEM to mitigate

market power.

It shows that the SEM is a highly regulated and administered market. In the forward timeframe liquidity is

mandated through the requirement to offer DCs and PSO related Contracts for Difference (CfD). The

physical market is a gross mandatory pool where participants must bid their short run marginal cost and

where prices are determined ex-post. Ancillary services are paid regulated tariffs and are required to run.

Capacity is separately remunerated through an administered price paid uniformly to all providers.

The mitigations are a mix of ex-ante and ex-post measures. Some apply to specific timeframes, while

others are market wide and apply across all timeframes. Similarly, some mitigations apply to all

participants while others target specific participants, such as ESB. Further, some measures are specific to

the SEM while others are driven from European law

ESB considers the current suite of market power mitigation measures under SEM to be disproportionate to

the level of risk and in this regard would reference the Baringa Report: Mitigating Market Power in the SEM

accompanying this response.

Table 3: SEM market power mitigations

SEM market Timeframe specific SEM wide Targeted and

SEM wide

Pan-

European

Forward – Directed Contracts

– Public Service Obligations

Market Monitoring Unit

Vertical ring-

fence

REMIT, MIFID II, EMIR, Transparency Regulation

Competition

law23

Pool – Bidding Code of Practice

– Two windows to alter DA offers

– Ex-post price determination

– Price cap or RMR

Balancing – Grid Code prohibits capacity withholding


Ancillary

services


– Annually approved regulated tariffs for reserve, reactive power and black start services

– Grid Code mandates

requirements on generators for

other services

CRM – Capacity payments are

23

Competition law is set out in Articles 101 and 102 of the Treaty on the Functioning of the European Union and is implemented in Irish law via the Competition Acts 2002 – 2014 and in UK law through the Competition Act 1998.


determined administratively and

paid to all capacity providers

As discussed in section 2, one of the key principles adopted by competition authorities is that any

intervention must be reasonable and proportionate, that is, it achieves its aim, but that:

It is no more onerous than is needed to achieve its aim; and

It does not produce disadvantages that are disproportionate to the aim.

While the RAs assess each measure individually in this section, we see no analysis of the effectiveness of

the overall package of measures nor an analysis of whether the package as a whole is proportionate to the

harm identified (either at SEM outset).

On the vertical ring-fencing for example, by the RAs’ own admission it is unclear how to assess the impact

individually, given the interaction with other measures. This is highlighted in section 7.2.23:

“Assessing the effectiveness of vertical ring-fencing on its own (i.e., as if no other market power mitigation

measures were in place) is difficult, partly because it is not straightforward to estimate the impact of

functional separation on generation and retail market performance, and partly because market outcomes

that can be observed may have been influenced by other mitigation measures.”

This highlights in stark terms the ‘pancaking’ of various market power mitigation measures under SEM.

This must be avoided under I-SEM – all interventions should be clearly justified to ensure they are

necessary as part of a package – particularly given that the Irish market will be much more integrated with

the European IEM.

Are there any particular aspects of the SEM market power mitigation strategy that you think should

be applied differently, especially in relation to I-SEM?

Please see sections 2 and 4.5

Chapter 8

Do you agree with the five key principles for assessing market power mitigation policies as

outlined in this section 8.3? If you think there should be alternatives, please state the reasoning?

In broad terms we agree with the five key principles outlined. However, as mentioned in section 2.1, we

would add an additional and overarching principle to ensure ‘proportionality’.

Given the extent of the changes to the market under I-SEM, and the consequent risks associated with

interventions that only apply in Ireland, we think a full impact assessment is required prior to finalising the

decision.

Questions relating to the Forward Contracting Obligation


Which of the balancing market mitigation options do you consider most appropriate, i.e. MMU-

triggered intervention, automated intervention via a PST or via the “flagging and tagging”

approach, or prescriptive bidding controls? Where feasible please relate the preferred approach

the five key principles for this workstream of effective, targeted, flexible, practical and transparent?



Which ex-ante bidding/offer market power mitigation options for the DA and ID markets do you

favour – bidding principles and ex-post assessment, or ex-post assessment only? Where feasible

please relate the preferred approach to the five key principles for this workstream of effective,

targeted, flexible, practical and transparent.


If ex-ante bidding principles were to be adopted, how flexible should they be and how would this

be facilitated/enshrined in their wording?


Under what structural conditions or in combination with other market power mitigation measures

should vertical ring-fencing of the incumbents be relaxed?


Under what circumstances and criteria (or metrics) should the application of ring-fencing to other

market participants be considered?

With the launch of I-SEM in 2017, Ireland will join the NWE region and be part of an integrated market

spanning 19 countries. The SEM currently imposes vertical ring-fencing on some but not all vertically

integrated players. This appears inconsistent with the future vision of pro-competitive integrated markets

under the IEM. We observe that other Member States who are already part of the IEM, namely Italy and

Portugal, have comparable market share of the largest incumbent and levels of interconnection but those

vertically integrated firms are not subject to such restrictions.


APPENDIX 2: I-SEM MARKET DEFINITIONS AND DESIGN FEATURES THAT MITIGATE MARKET POWER

As mentioned in section 3.1, this appendix shows the numerous design features of I-SEM that mitigate market power. We note that at the time of

this response a number of decisions are still to be made.

Market Product Geography Design features that mitigate market power

Forward Any physical or financial

market where a participant

can manage its forward

market exposures

Regional

(I-SEM + GB)

– Forwards and liquidity workstream is ongoing

– The existence of attractive proxy hedges with GB gas and EUA carbon or GB power

– The addition of FTRs for cross-border trade will increase competition

Day

Ahead

A physical contract to

generate or supply

electricity, traded through

day ahead auctions

Pan-European – Exclusive route to the physical market in I-SEM

– Unit bidding requirement

– Increased participation of the demand side

– The day ahead market is by design and definition a pan-European market.

– The alignment of trading timeframes with European markets and common rules will increase competition

– The EUPHEMIA algorithm optimises social welfare and schedules flows subject to transmission constraints

– FTRs will help focus liquidity into DA market

Intraday A physical contract to

generate or supply

electricity, traded through

continuous intraday

platforms

Pan-European – The intraday market is by design and definition a pan-European market.



– The alignment of trading timeframes with Europe will increase competition

– Continuous ID trading will increase the trading efficiency albeit at the expense of

ID liquidity

Balancing Incremental offers to

increase

production/decrease

consumption or decremental

bids to decrease

production/increase or

consumption

Island of

Ireland


– Mandatory bidding


– Grid Code prohibits capacity withholding

– Alignment of gate closure times with Europe will increase competition

– The network code on balancing facilitates TSO-TSO trading of common products

via a common merit order, increasing competition for balancing services